Clear Height Misrepresented in OM - Thoughts?

Question

We're in contract on a small bay industrial warehouse in the Phoenix metro area. We toured it today. It's a fantastic location and 100% leased. Downsides we were aware of is that there's too much office buildout And instead of overhead doors they have these stupid pedestrian double doors. But we were willing to deal with all of that. However we just discovered that the clear height is only 11 ft 7 in. The OM said it was 14 ft and the standard for the area which is very dense with this product type is 14'-16'. The leasing company that leases 95% of this product type in the area says this will eliminate 50% of prospective tenants.

however it is an incredible incredible location And currently 100% leased.

question one. Do we ask for a discount or do we walk?

question two if we ask for a discount, how do we quantify it?

thanks!

Kim

John Teachout · Answer

Usually any kind of commercial door is 14'+ because 13' 6" is a common height limit for highway vehicles. So lots of RVs wouldn't fit into this building. However, if the location is good and the space is full, I'd move forward with it as not everyone's stuff is tall.

Cole Bigbee · Answer

@Kim Hopkins Is the structure an actual metal building, or is it block and bar joist? Do you have pics of the inside you can share? If it is a metal building, I am assuming when you say clear height that is underneath where the rafter and column come together or are your saying that is the clear height everywhere on the inside? If it is a true metal building, there is a lot you can do to better accommodate tenants, including cutting in larger overhead doors and removing some office space without compromising the structure. Industrial projects are my specialty and I am happy to help in anyway I can. Sounds like if it is 100% leased and the number's work, it is a no brainer.

Andrew Tripp · Answer

Yeah, a discount is the starting point. If they balk, then decide whether to terminate (and then negotiate a discount). This is a problem that isn't going away for them. But if they had backup offers, then you are out there battling again. But you are probably going to have to stick to your guns because this will come again on exit. How to quantify the discount is a bit difficult. James Storey has the the right approach I think. Should be some lease comps out there that can help you build a base case/downside sensitivity analysis. But another wrinkle is what is the specific leasing strategy for this asset if you have to backfill vacancy down the line? Is this an airport-based use? Logistics/freight forwarding use is going to be challenging with a 11'7" clear height (and the other physical dimensions), no matter what the broker/CoStar reports say. Machine shop/light assembly isn't going to care as much about clear heights. R&D/flex can probably deal with that kind clear height just fine as well. Construction-type uses may be tougher as they might not be able to get equipment over a certain size in there. Retail-ish consumer facing uses might be OK as long as they don't have to rack too much product. We had this come up on a deal in the past (that we didn't wind up getting for other reasons) where the building had 12.5 foot clear when market was 15-18 clear. To be very conservative, we discounted $2 psf off market rents (modified gross) in our projections. And put in a longer lease-up period. It was a great submarket with very solid underlying demand and supply drivers for small bay space, similar to what it sounds like you have here. Hopefully this helps.

James Storey · Answer

Yeah I would start with seeing how much different rents might be between the ceiling heights. I don't know about Arizona, but here in Indiana, the difference for a modern clear height to a much lower clear height is about $1/sf-$2.5/sf NNN for warehouse space. That being said, I would take an analytical approach and figure out what your NOI would look like if you had to re-lease the space once this tenants lease expires. If the difference in rent is about $1/sf, I would take that $1/sf for the remainder of a 10 year proforma and discount it back at particular discount rate. A good rate might be a rate that is closely aligned with a market CAP rate in this instance. Whatever the present value of the NOI differential is is what I would ask for a discount.In my opinion, this is how you would quantify the discount but most people wouldn't take the time to do this type of calculation so you might want to ask for a discount based on your gut telling you what your risk tolerance is. That being said, convincing the seller of these findings is a completely different ball game. Wish you the best of luck.James Storey, CCIM

Jack Inman · Answer

@Kim Hopkins Probably worth going for a discount first. For quantifying the amount, I'd start by seeing if that leasing company you mentioned could give you an idea on how much the difference in potential rent is between a 14ft clearance and the 11'7" clearance is. Loosing 50% of the potential tenant pool is never a good thing, but if the seller is willing to give you a discount to offset that drop in value then I see no reason to back out.

Kim Hopkins · Answer

Thanks @Andrew Tripp! Will let you know how it turns out with the request for a credit.

Andrew Tripp · Answer

Yes, we are local to Chicago. Four assets in select submarkets here. O'Hare/I-90 corridor, and branching out into northern Kane/McHenry/Lake counties.I like your website. And nice portfolio coming together as well!

Kim Hopkins · Answer

Hi @Andrew Tripp, our company is Iron Peak Properties. Is your group local to Chicago?

Andrew Tripp · Answer

@Kim Hopkins, remind me again what the name of your firm is (if you don't mind sharing)? Sounds like you guys are doing some interesting things.Also, a couple of people here started a mastermind/networking group for commercial investors (non-multifamily division) where we spending some time doing this kind deal dive on what we are working on. A few industrial-focused investors in there. If you're interested, DM me and I can put you in touch with the organizers. Also a FB group to go along with it.

Kim Hopkins · Answer

@Andrew Tripp Hi Andrew, that's really good advice and makes me think a lot about our situation. This not our first deal. We are experienced investors and long-term-holders. We want properties that cash flow. We're also a 2-person shop so there is a major opportunity cost if we buy a property that doesn't cash flow or worse, doesn't cash flow and costs us time and headache. So your story about your first deal which sounds like this one is very helpful. We don't need this deal to get started and don't want that experience if we can avoid it. My original thinking here was A) we should break into the Phoenix market sooner rather than later at the cost of cash flow so we could get established in a market we'd like to be in long term and B) I thought there was a rush to find a deal before inflation hits and/or interest rates rise. I'm not necessarily sure I was wrong on this, especially B, but we are still seeing some new deals come through in better cash flowing markets like DFW, still expensive, but better cash flow than this. Although there is the thing about the bird in the hand...Still so on the fence with this one. I guess I'll see what he says with the credit. I'd usually ignore the opex like you said, but the margins may be too slim otherwise.